XNAS:PEBK Peoples Bancorp of NC Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
     
 
FORM 10-Q
 
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended:   June 30, 2012
 
OR
 
[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________ to __________
 
PEOPLES BANCORP OF NORTH CAROLINA, INC.
(Exact name of registrant as specified in its charter)
 
North Carolina
(State or other jurisdiction of incorporation or organization)
 
000-27205
56-2132396
(Commission File No.)
(IRS Employer Identification No.)
 
518 West C Street, Newton, North Carolina
28658
(Address of principal executive offices)
(Zip Code)
 
(828) 464-5620
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes
  X  
No
   
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 
 
Yes
  X  
No
   
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large Accelerate Filer
   
Accelerated Filer
   
Non-Accelerated Filer
   
 
Smaller Reporting Company
X
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2 of the Exchange Act).
 
Yes
   
No
  X  
 
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
5,544,160 shares of common stock, outstanding at July 31, 2012.
 
 
 
 

 
 
 
INDEX
         
PART I.
FINANCIAL INFORMATION
PAGE(S)
 
         
Item 1.
 
Financial Statements
   
         
   
Consolidated Balance Sheets at June 30, 2012 (Unaudited) and December
   
   
31, 2011 (Audited)
3
 
         
   
Consolidated Statements of Earnings for the three and six months ended
   
   
June 30, 2012 and 2011 (Unaudited)
4
 
         
   
Consolidated Statements of Comprehensive Income for the three and six
   
   
months ended June 30, 2012 and 2011 (Unaudited)
5
 
         
   
Consolidated Statements of Cash Flows for the six months ended June 30,
   
   
2012 and 2011 (Unaudited)
6-7
 
         
   
Notes to Consolidated Financial Statements (Unaudited)
8-22
 
         
Item 2.
 
Management's Discussion  and Analysis of Financial Condition
   
   
and Results of Operations
23-37
 
         
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
38
 
         
Item 4T.
 
Controls and Procedures
39
 
         
PART II.
OTHER INFORMATION
   
         
Item 1.
 
Legal Proceedings
40
 
Item 1A.
 
Risk Factors
40
 
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
40
 
Item 3.
 
Defaults upon Senior Securities
40
 
Item 5.
 
Other Information
40
 
Item 6.
 
Exhibits
40-43
 
Signatures
 
44
 
Certifications
 
45-47
 
 
 
 
Statements made in this Form 10-Q, other than those concerning historical information, should be considered forward-looking statements pursuant to the safe harbor provisions of the Securities Exchange Act of 1934 and the Private Securities Litigation Act of 1995.  These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management and on the information available to management at the time that this Form 10-Q was prepared.  These statements can be identified by the use of words like “expect,” “anticipate,” “estimate,” and “believe,” variations of these words and other similar expressions.  Readers should not place undue reliance on forward-looking statements as a number of important factors could cause actual results to differ materially from those in the forward-looking statements.  Factors that could cause actual results to differ materially include, but are not limited to, (1) competition in the markets served by Peoples Bank, (2) changes in the interest rate environment, (3) general national, regional or local economic conditions may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and the possible impairment of collectibility of loans, (4) legislative or regulatory changes, including changes in accounting standards, (5) significant changes in the federal and state legal and regulatory environments and tax laws, (6) the impact of changes in monetary and fiscal policies, laws, rules and regulations and (7) other risks and factors identified in other filings with the Securities and Exchange Commission, including but not limited to those described in Peoples Bancorp of North Carolina, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2011.
 
 
 
 
2

 
 
 
PART I.
FINANCIAL INFORMATION
   
Item 1.
Financial Statements
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
         
Consolidated Balance Sheets
         
(Dollars in thousands)
 
June 30,
 
December 31,
Assets
2012
 
2011
 
(Unaudited)
 
(Audited)
         
Cash and due from banks, including reserve requirements
$ 25,350   22,532  
of $9,265 in 2012 and $8,492 in 2011
         
Interest bearing deposits
  44,127   6,704  
Cash and cash equivalents
  69,477   29,236  
           
           
Investment securities available for sale
  280,735   321,388  
Other investments
  5,734   5,712  
Total securities
  286,469   327,100  
           
Mortgage loans held for sale
  3,753   5,146  
           
Loans
  642,815   670,497  
Less allowance for loan losses
  (16,640 ) (16,604 )
Net loans
  626,175   653,893  
           
Premises and equipment, net
  16,342   16,896  
Cash surrender value of life insurance
  13,040   12,835  
Other real estate
  6,505   7,576  
Accrued interest receivable and other assets
  13,328   14,381  
Total assets
$ 1,035,089   1,067,063  
           
Liabilities and Shareholders' Equity
         
           
Deposits:
         
Non-interest bearing demand
$ 147,825   136,878  
NOW, MMDA & savings
  353,076   366,133  
Time, $100,000 or more
  156,974   193,045  
Other time
  122,671   131,055  
Total deposits
  780,546   827,111  
           
Securities sold under agreements to repurchase
  50,510   39,600  
FHLB borrowings
  70,000   70,000  
Junior subordinated debentures
  20,619   20,619  
Accrued interest payable and other liabilities
  18,574   6,706  
Total liabilities
  940,249   964,036  
           
Commitments
         
           
Shareholders' equity:
         
           
Series A preferred stock, $1,000 stated value; authorized
         
5,000,000 shares; issued and outstanding
         
12,524 shares in 2012 and 25,054 shares in 2011
  12,298   24,758  
Common stock, no par value; authorized 20,000,000 shares;
         
issued and outstanding 5,544,160 shares in 2012 and 2011
  48,298   48,298  
Retained earnings
  29,617   26,895  
Accumulated other comprehensive income
  4,627   3,076  
Total shareholders' equity
  94,840   103,027  
           
Total liabilities and shareholders' equity
$ 1,035,089   1,067,063  
           
See accompanying Notes to Consolidated Financial Statements.
         
 
 
 
3

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
                 
Consolidated Statements of Earnings
                 
Three and six months ended June 30, 2012 and 2011
                 
(Dollars in thousands, except per share amounts)
                 
 
Three months ended
 
Six months ended
 
 
June 30,
 
June 30,
 
 
2012
 
2011
 
2012
 
2011
 
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
Interest income:
               
Interest and fees on loans
$ 8,227   9,159   16,652   18,774  
    Interest on due from banks   16   8   19   14  
Interest on investment securities:
                 
U.S. Government sponsored enterprises,
                 
including mortgage-backed securities
  737   1,413   1,807   2,494  
States and political subdivisions
  787   790   1,587   1,595  
Other
  68   52   132   102  
Total interest income
  9,835   11,422   20,197   22,979  
                   
Interest expense:
                 
NOW, MMDA & savings deposits
  295   601   639   1,319  
Time deposits
  864   1,277   1,896   2,681  
FHLB borrowings
  684   753   1,374   1,497  
Junior subordinated debentures
  110   101   222   200  
Other
  34   77   73   156  
Total interest expense
  1,987   2,809   4,204   5,853  
                   
Net interest income
  7,848   8,613   15,993   17,126  
                   
Provision for loan losses
  1,603   3,368   3,652   6,318  
                   
Net interest income after provision for loan losses
  6,245   5,245   12,341   10,808  
                   
Non-interest income:
                 
Service charges
  1,192   1,316   2,379   2,572  
Other service charges and fees
  516   528   1,115   1,109  
Gain on sale of securities
  664   181   1,191   1,256  
Mortgage banking income
  271   218   497   405  
Insurance and brokerage commissions
  119   121   254   229  
Loss on sale and write-down of
                 
other real estate
  (195 ) (361 ) (384 ) (708 )
Miscellaneous
  1,026   733   1,920   1,446  
Total non-interest income
  3,593   2,736   6,972   6,309  
                   
Non-interest expense:
                 
Salaries and employee benefits
  3,931   3,673   7,772   7,340  
Occupancy
  1,300   1,331   2,600   2,696  
Other
  2,612   2,404   4,742   4,742  
Total non-interest expense
  7,843   7,408   15,114   14,778  
                   
Earnings before income taxes
  1,995   573   4,199   2,339  
                   
Income tax expense (benefit)
  486   (56 ) 1,031   349  
                   
Net earnings
  1,509   629   3,168   1,990  
                   
Dividends and accretion on preferred stock
  348   348   697   697  
                   
Net earnings available to common shareholders
$ 1,161   281   2,471   1,293  
                   
Basic net earnings per common share
$ 0.21   0.05   0.45   0.23  
Diluted net earnings per common share
$ 0.21   0.05   0.45   0.23  
Cash dividends declared per common share
$ 0.02   0.02   0.09   0.04  
                   
See accompanying Notes to Consolidated Financial Statements.
             
 
 
 
4

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
                 
Consolidated Statements of Comprehensive Income
                 
Three and Six Months Ended June 30, 2012 and 2011
                 
 (Dollars in thousands)
                 
 
Three months ended
 
Six months ended
 
 
June 30,
 
June 30,
 
 
2012
 
2011
 
2012
 
2011
 
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
                 
Net earnings
$ 1,509   629   3,168   1,990  
                   
Other comprehensive income:
                 
Unrealized holding gains on securities
                 
available for sale
  2,513   5,568   3,730   6,041  
Reclassification adjustment for gains on
                 
securities available for sale
                 
included in net earnings
  (664 ) (181 ) (1,191 ) (1,256 )
Unrealized holding losses on derivative
                 
financial instruments qualifying as cash flow
                 
hedges
  -      (264 ) -      (648 )
                   
Total other comprehensive income,
                 
before income taxes
  1,849   5,123   2,539   4,137  
                   
Income tax expense related to other
                 
comprehensive income:
                 
                   
Unrealized holding gains on securities
                 
available for sale
  979   2,168   1,452   2,353  
Reclassification adjustment for gains 
                 
on securities available for sale
                 
included in net earnings
  (259 ) (70 ) (464 ) (489 )
Unrealized holding losses on derivative
                 
financial instruments qualifying as cash flow
                 
hedges
  -      (103 ) -      (253 )
                   
Total income tax expense related to
                 
other comprehensive income
  720   1,995   988   1,611  
                   
Total other comprehensive income,
                 
net of tax
  1,129   3,128   1,551   2,526  
                   
Total comprehensive income
$ 2,638   3,757   4,719   4,516  
                   
See accompanying Notes to Consolidated Financial Statements.
             
 
 
 
5

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
 
         
Consolidated Statements of Cash Flows
 
         
Six Months Ended June 30, 2012 and 2011
 
         
(Dollars in thousands)
 
         
 
2012
 
2011
 
 
(Unaudited)
 
(Unaudited)
 
         
Cash flows from operating activities:
       
Net earnings
$ 3,168   1,990  
Adjustments to reconcile net earnings to
         
net cash provided by operating activities:
         
Depreciation, amortization and accretion
  4,406   2,853  
Provision for loan losses
  3,652   6,318  
Gain on sale of investment securities
  (1,191 ) (1,256 )
Loss on sale of other real estate
  40   143  
Write-down of other real estate
  344   565  
Restricted stock expense
  17   7  
Change in:
         
Mortgage loans held for sale
  1,393   1,847  
Cash surrender value of life insurance
  (205 ) (121 )
Other assets
  (267 ) 394  
Other liabilities
  11,867   (135 )
           
Net cash provided by operating activities
  23,224   12,605  
           
Cash flows from investing activities:
         
Purchases of investment securities available for sale
  (25,473 ) (80,971 )
Proceeds from calls, maturities and paydowns of investment securities
         
available for sale
  31,641   24,749  
Proceeds from sales of investment securities available for sale
  34,788   35,269  
Purchases of other investments
  (493 ) (232 )
Proceeds from sale of other investments
  471   153  
Net change in loans
  21,662   24,691  
Purchases of premises and equipment
  (426 ) (1,214 )
Proceeds from sale of other real estate
  3,406   1,679  
           
Net cash provided by investing activities
  65,576   4,124  
           
Cash flows from financing activities:
         
Net change in deposits
  (46,565 ) (8,302 )
Net change in demand notes payable to U.S. Treasury
  -      (348 )
Net change in securities sold under agreement to repurchase
  10,910   10,418  
Proceeds from FHLB borrowings
  25,400   5,000  
Repayments of FHLB borrowings
  (25,400 ) (5,000 )
Preferred Stock Repurchase
  (11,695 ) -     
Restricted stock payout
  -      9  
Cash dividends paid on Series A preferred stock
  (710 ) (626 )
Cash dividends paid on common stock
  (499 ) (222 )
           
Net cash (used) provided by financing activities
  (48,559 ) 929  
           
Net change in cash and cash equivalent
  40,241   17,658  
           
Cash and cash equivalents at beginning of period
  29,236   23,977  
           
Cash and cash equivalents at end of period
$ 69,477   41,635  
 
 
 
6

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
         
Consolidated Statements of Cash Flows, continued
         
Six Months Ended June 30, 2012 and 2011
         
(Dollars in thousands)
         
         
 
2012
 
2011
 
 
(Unaudited)
 
(Unaudited)
 
         
Supplemental disclosures of cash flow information:
       
Cash paid during the year for:
       
Interest
$ 4,737   5,924  
Income taxes
$ 985   112  
           
Noncash investing and financing activities:
         
Change in unrealized gain on investment securities
         
 available for sale, net
$ 1,551   (2,921 )
Change in unrealized gain on derivative financial
         
 instruments, net
$ -      395  
Transfer of loans to other real estate and repossessions
$ 2,707   6,051  
Financed portion of sale of other real estate
$ 303   3,222  
Accretion of Series A preferred stock
$ 70   70  
        Discount on preferred stock $ 835   -      
           
           
See accompanying Notes to Consolidated Financial Statements.
         
 
 
 
7

 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

(1)
    Summary of Significant Accounting Policies

The consolidated financial statements include the financial statements of Peoples Bancorp of North Carolina, Inc. and its wholly-owned subsidiaries, Peoples Bank (the “Bank”) and Community Bank Real Estate Solutions, LLC, along with the Bank’s wholly-owned subsidiaries, Peoples Investment Services, Inc. and Real Estate Advisory Services, Inc. (“REAS”) (collectively called the “Company”).  All significant intercompany balances and transactions have been eliminated in consolidation.

The consolidated financial statements in this report are unaudited.  In the opinion of management, all adjustments (none of which were other than normal accruals) necessary for a fair presentation of the financial position and results of operations for the periods presented have been included.  Management of the Company has made a number of estimates and assumptions relating to reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”).  Actual results could differ from those estimates.

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition.  Many of the Company’s accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of the specific accounting guidance.  A description of the Company’s significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2011 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May 3, 2012 Annual Meeting of Shareholders.

Recently Issued Accounting Pronouncements
In April 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. ASU No. 2011-02 provides additional guidance for determining what constitutes a troubled debt restructuring.  ASU No. 2011-02 is effective for interim and annual periods ending after June 15, 2011.  The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.

In May 2011, FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”).  ASU No. 2011-04 is intended to result in convergence between GAAP and IFRS requirements for measurement of and disclosures about fair value.  ASU No. 2011-04 is effective for interim and annual periods beginning after December 15, 2011.  The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.

In June 2011, FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income.  ASU No. 2011-05 requires companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements.  It eliminates the option to present components of other comprehensive income as part of the statement of changes in shareholders’ equity.  ASU No. 2011-05 does not change the items which must be reported in other comprehensive income, how such items are measured or when they must be reclassified to net income.  ASU No. 2011-05 is effective for interim and annual periods beginning after December 15, 2011.  Because ASU No. 2011-05 impacts presentation only, it has no impact on the Company’s results of operations or financial position.

In December 2011, FASB issued ASU No. 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.  ASU No. 2011-12 defers the effective date of the requirement to present separate line items on the income statement for reclassification adjustments of items out of accumulated other comprehensive income into net income.  This deferral is temporary until  FASB reconsiders the operational concerns and needs of financial statement users.  FASB has not yet established a timetable for its reconsideration.  Entities are still required to present reclassification adjustments within other comprehensive income either on the face of the statement that reports other comprehensive income or in the notes to the financial statements.  The requirement to present comprehensive income in either a single continuous statement or two consecutive condensed statements remains for both annual and interim reporting.  Because ASU No. 2011-12 impacts presentation only, it will have no impact on the Company’s results of operations or financial position.
 
 
8

 
 
Other accounting standards that have been issued or proposed by FASB or other standards-setting bodies are not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

(2)
    Investment Securities

Investment securities available for sale at June 30, 2012 and December 31, 2011 are as follows:

(Dollars in thousands)
             
 
June 30, 2012
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated Fair
Value
Mortgage-backed securities
$ 164,423   1,981   383   166,021
U.S. Government
               
sponsored enterprises
  2,853   77   -      2,930
State and political subdivisions
  102,342   5,368   35   107,675
Corporate bonds
  1,539   6   -      1,545
Trust preferred securities
  1,250   -      -      1,250
Equity securities
  748   566   -      1,314
Total
$ 273,155   7,998   418   280,735
                 
(Dollars in thousands)
               
 
December 31, 2011
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated Fair
Value
Mortgage-backed securities
$ 213,378   1,371   1,056   213,693
U.S. Government
               
sponsored enterprises
  7,429   265   -      7,694
State and political subdivisions
  92,996   4,157   56   97,097
Corporate bonds
  546   -      3   543
Trust preferred securities
  1,250   -      -      1,250
Equity securities
  748   363   -      1,111
Total
$ 316,347   6,156   1,115   321,388
 
The current fair value and associated unrealized losses on investments in securities with unrealized losses at June 30, 2012 and December 31, 2011 are summarized in the tables below, with the length of time the individual securities have been in a continuous loss position.
 
(Dollars in thousands)
                     
 
June 30, 2012
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
Mortgage-backed securities
$ 50,288   331   2,979   52   53,267   383
State and political subdivisions
  4,149   35   -      -      4,149   35
Total
$ 54,437   366   2,979   52   57,416   418
 
 
(Dollars in thousands)
                     
 
December 31, 2011
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
Mortgage-backed securities
$ 95,122   991   4,125   65   99,247   1,056
State and political subdivisions
  4,444   56   -      -      4,444   56
Corporate bonds
  542   3   -      -      542   3
Total
$ 100,108   1,050   4,125   65   104,233   1,115
 
 
 
9

 
 
At June 30, 2012, unrealized losses in the investment securities portfolio relating to debt securities totaled $418,000.  The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary.  From the June 30, 2012 tables above, four out of 134 securities issued by state and political subdivisions contained unrealized losses and 28 out of 93 securities issued by U.S. Government sponsored enterprises, including mortgage-backed securities, contained unrealized losses.  These unrealized losses are considered temporary because of acceptable investment grades on each security and the repayment sources of principal and interest are government backed.

The amortized cost and estimated fair value of investment securities available for sale at June 30, 2012, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

(Dollars in thousands)
     
 
Amortized
Cost
 
Estimated Fair
Value
Due within one year
$ 2,604   2,648
Due from one to five years
  13,130   13,489
Due from five to ten years
  80,180   84,321
Due after ten years
  12,070   12,942
Mortgage-backed securities
  164,423   166,021
Equity securities
  748   1,314
Total
$ 273,155   280,735
 
Proceeds from sales of securities available for sale during the six months ended June 30, 2012 were $34.8 million and resulted in gross gains of $1.2 million.  Proceeds from sales of securities available for sale during the six months ended June 30, 2011 were $35.3 million and resulted in gross gains of $1.3 million.

Securities with a fair value of approximately $87.2 million and $83.6 million at June 30, 2012 and December 31, 2011, respectively, were pledged to secure public deposits and for other purposes as required by law.

(3)
    Loans

Major classifications of loans at June 30, 2012 and December 31, 2011 are summarized as follows:

(Dollars in thousands)
     
 
June 30, 2012
 
December 31, 2011
Real estate loans
     
     Construction and land development
$ 86,498   93,812
     Single-family residential
  255,339   267,051
     Commercial
  207,245   214,415
     Multifamily and farmland
  5,285   4,793
          Total real estate loans
  554,367   580,071
         
Commercial loans (not secured by real estate)
  59,416   60,646
Consumer loans (not secured by real estate)
  10,205   10,490
All other loans (not secured by real estate)
  18,827   19,290
     Total loans
  642,815   670,497
         
Less allowance for loan losses
  16,640   16,604
         
     Total net loans
$ 626,175   653,893
 
The Bank grants loans and extensions of credit primarily within the Catawba Valley region of North Carolina, which encompasses Catawba, Alexander, Iredell and Lincoln counties and also in Mecklenburg, Union and Wake counties of North Carolina.  Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by improved and unimproved real estate, the value of which is dependent upon the real estate market.

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
 
10

 
 
The following tables present an age analysis of past due loans, by loan type, as of June 30, 2012 and December 31, 2011:

June 30, 2012
               
(Dollars in thousands)
               
 
Loans 30-89
Days Past
Due
Loans 90 or
More Days
Past Due
 
Total Past
Due
Loans
Total
Current
Loans
 
Total Loans
 
Accruing
Loans 90 or
More Days
Past Due
Real estate loans
                     
     Construction and land development
$ 6,538   3,012   9,550   76,948   86,498   -   
     Single-family residential
  6,711   4,175   10,886   244,453   255,339   1,797
     Commercial
  2,161   1,543   3,704   203,541   207,245   -   
     Multifamily and farmland
  -      -      -      5,285   5,285   -   
          Total real estate loans
  15,410   8,730   24,140   530,227   554,367   1,797
                         
Commercial loans (not secured by real estate)
  743   17   760   58,656   59,416   -   
Consumer loans (not secured by real estate)
  102   4   106   10,099   10,205   -   
All other loans (not secured by real estate)
  -      -      -      18,827   18,827   -   
     Total loans
$ 16,255   8,751   25,006   617,809   642,815   1,797
 
 
December 31, 2011
               
(Dollars in thousands)
               
 
Loans 30-89
Days Past
Due
Loans 90 or
More Days
Past Due
 
Total Past
Due
Loans
Total
Current
Loans
 
Total Loans
 
Accruing
Loans 90 or
More Days
Past Due
Real estate loans
                     
     Construction and land development
$ 10,033   3,338   13,371   80,441   93,812   -   
     Single-family residential
  16,536   6,189   22,725   244,326   267,051   2,709
     Commercial
  1,002   958   1,960   212,455   214,415   -   
     Multifamily and farmland
  13   -      13   4,780   4,793   -   
          Total real estate loans
  27,584   10,485   38,069   542,002   580,071   2,709
                         
Commercial loans (not secured by real estate)
  576   9   585   60,061   60,646   -   
Consumer loans (not secured by real estate)
  116   36   152   10,338   10,490   -   
All other loans (not secured by real estate)
  -      -      -      19,290   19,290   -   
     Total loans
$ 28,276   10,530   38,806   631,691   670,497   2,709
 
The following table presents the Company’s non-accrual loans as of June 30, 2012 and December 31, 2011:
 
(Dollars in thousands)
     
 
June 30, 2012
 
December 31, 2011
Real estate loans
     
     Construction and land development
$ 12,624   13,257
     Single-family residential
  4,626   5,522
     Commercial
  3,234   2,451
     Multifamily and farmland
  -      -   
          Total real estate loans
  20,484   21,230
         
Commercial loans (not secured by real estate)
  575   403
Consumer loans (not secured by real estate)
  15   152
     Total
$ 21,074   21,785
 
 
 
11

 
 
At each reporting period, the Bank determines which loans are impaired.  Accordingly, the Bank’s impaired loans are reported at their estimated fair value on a non-recurring basis.  An allowance for each impaired loan, which is generally collateral-dependent, is calculated based on the fair value of its collateral.  The fair value of the collateral is based on appraisals performed by REAS, a subsidiary of the Bank.  REAS is staffed by certified appraisers that also perform appraisals for other companies.   Factors including the assumptions and techniques utilized by the appraiser are considered by management.  If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses.  Impaired loans under $250,000 are not individually evaluated for impairment, with the exception of the Bank’s troubled debt restructured (“TDR”) loans in the residential mortgage loan portfolio, which are individually evaluated for impairment.  Accruing impaired loans were $35.0 million, $20.3 million and $30.6 million at June 30, 2012, June 30, 2011 and December 31, 2011, respectively.  Interest income recognized on accruing impaired loans was $1.1 million, $595,000 and $1.7 million for the six months ended June 30, 2012, the six months ended June 30, 2011 and the year ended December 31, 2011, respectively.  No interest income is recognized on non-accrual impaired loans subsequent to their classification as impaired.

The following tables present the Company’s impaired loans as of June 30, 2012 and December 31, 2011:

June 30, 2012
                   
(Dollars in thousands)
                   
 
Unpaid Contractual Principal
Balance
 
Recorded Investment
With No Allowance
 
Recorded Investment
With
Allowance
 
Recorded Investment
in Impaired
Loans
 
Related
Allowance
 
Average Outstanding Impaired
Loans
Real estate loans
                     
     Construction and land development
$ 28,750   12,377   7,960   20,337   2,470   14,990
     Single-family residential
  29,103   5,475   22,927   28,402   1,533   28,841
     Commercial
  6,250   5,018   663   5,681   299   4,872
     Multifamily and farmland
  201   201   -      201   -      202
          Total impaired real estate loans
  64,304   23,071   31,550   54,621   4,302   48,905
                         
Commercial loans (not secured by real estate)
  1,408   1,408   -      1,408   15   1,222
Consumer loans (not secured by real estate)
  22   -      17   17   -      42
     Total impaired loans
$ 65,734   24,479   31,567   56,046   4,317   50,169
 
 
December 31, 2011
                   
(Dollars in thousands)
                   
 
Unpaid Contractual Principal
Balance
 
Recorded Investment
With No Allowance
 
Recorded Investment
With
Allowance
 
Recorded Investment
in Impaired
Loans
 
Related
Allowance
 
Average Outstanding Impaired
Loans
Real estate loans
                     
     Construction and land development
$ 28,721   14,484   6,098   20,582   3,264   17,848
     Single-family residential
  26,382   969   24,719   25,688   1,427   25,102
     Commercial
  7,717   3,845   3,139   6,984   77   4,518
     Multifamily and farmland
  209   -      209   209   1   214
          Total impaired real estate loans
  63,029   19,298   34,165   53,463   4,769   47,682
                         
Commercial loans (not secured by real estate)
  1,111   -      1,083   1,083   26   1,485
Consumer loans (not secured by real estate)
  157   -      152   152   2   140
     Total impaired loans
$ 64,297   19,298   35,400   54,698   4,797   49,307
 
Changes in the allowance for loan losses for the six months ended June 30, 2012 and the year ended December 31, 2011 were as follows:
 
 
 
12

 

 
Six months ended June 30, 2012
                     
(Dollars in thousands)
                         
 
Real Estate Loans
                 
 
Construction and Land Development
 
Single-
Family Residential
 
Commercial
 
Multifamily
and
Farmland
 
Commercial
 
Consumer
and All
Other
 
Unallocated
 
Total
 
Allowance for loan losses:
                             
Beginning balance
$ 7,182   5,357   1,731   13   1,029   255   1,037   16,604  
Charge-offs
  (2,381 ) (861 ) (523 ) -   (343 ) (268 ) -   (4,376 )
Recoveries
  218   69   374   -   11   88   -   760  
Provision
  2,626   561   (66 ) -   (68 ) 116   483   3,652  
Ending balance
$ 7,645   5,126   1,516   13   629   191   1,520   16,640  
                                   
Ending balance: individually
                             
evaluated for impairment
$ 1,101   1,364   -   -   -   -   -   2,465  
Ending balance: collectively
                             
 evaluated for impairment
  6,544   3,762   1,516   13   629   191   1,520   14,175  
Ending balance
$ 7,645   5,126   1,516   13   629   191   1,520   16,640  
                                   
Loans:
                                 
Ending balance
$ 86,498   255,339   207,245   5,285   59,416   29,032   -   642,815  
                                   
Ending balance: individually
                             
evaluated for impairment
$ 19,789   23,452   4,961   -   362   -   -   48,564  
Ending balance: collectively
                             
 evaluated for impairment
$ 66,709   231,887   202,284   5,285   59,054   29,032   -   594,251  
 
 
Year ended December 31, 2011
                     
(Dollars in thousands)
                       
 
Real Estate Loans
                 
 
Construction and Land Development
 
Single-
Family Residential
 
Commercial
 
Multifamily and
Farmland
 
Commercial
 
Consumer
and All
Other
 
Unallocated
 
Total
 
Allowance for loan losses:
                             
Beginning balance
$ 5,774   6,097   1,409   17   1,174   430   592   15,493  
Charge-offs
  (7,164 ) (2,925 ) (1,271 ) -   (314 ) (586 ) -   (12,260 )
Recoveries
  241   201   24   -   121   152   -   739  
Provision
  8,331   1,984   1,569   (4 ) 48   259   445   12,632  
Ending balance
$ 7,182   5,357   1,731   13   1,029   255   1,037   16,604  
                                   
Ending balance: individually
                             
evaluated for impairment
$ 1,250   1,289   -   -   -   -   -   2,539  
Ending balance: collectively
                             
 evaluated for impairment
  5,932   4,068   1,731   13   1,029   255   1,037   14,065  
Ending balance
$ 7,182   5,357   1,731   13   1,029   255   1,037   16,604  
                                   
Loans:
                                 
Ending balance
$ 93,812   267,051   214,415   4,793   60,646   29,780   -   670,497  
                                   
Ending balance: individually
                             
evaluated for impairment
$ 20,280   20,661   3,845   -   -   -   -   44,786  
Ending balance: collectively
                             
 evaluated for impairment
$ 73,532   246,390   210,570   4,793   60,646   29,780   -   625,711  
 
The Company utilizes an internal risk grading matrix to assign a risk grade to each of its loans.  Loans are graded on a scale of 1 to 9.  These risk grades are evaluated on an ongoing basis.  A description of the general characteristics of the nine risk grades is as follows:

·  
Risk Grade 1 – Excellent Quality: Loans are well above average quality and a minimal amount of credit risk exists.  CD or cash secured loans or properly margined actively traded stock or bond secured loans would fall in this grade.
·  
Risk Grade 2 – High Quality: Loans are of good quality with risk levels well within the Company’s range of acceptability.  The organization or individual is established with a history of successful performance though somewhat susceptible to economic changes.
·  
Risk Grade 3 – Good Quality: Loans of average quality with risk levels within the Company’s range of acceptability but higher than normal. This may be a new organization or an existing organization in a transitional phase (e.g. expansion, acquisition, market change).

 
 
13

 
 

·  
Risk Grade 4 – Management Attention: These loans have very high risk and servicing needs but still are acceptable. Evidence of marginal performance or deteriorating trends are evident.  These are not problem credits presently, but may be in the future if the borrower is unable to change its present course.
·  
Risk Grade 5 – Watch: These loans are currently performing satisfactorily, but there are potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Company’s position at some future date.  This frequently results from deviating from prudent lending practices, for instance over-advancing on collateral.
·  
Risk Grade 6 – Substandard: A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or the collateral pledged (if there is any).  There is a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  There is a distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
·  
Risk Grade 7 – Low Substandard: These loans have the general characteristics of a Grade 6 Substandard loan, with heightened potential concerns.  The exact amount of loss is not yet known because neither the liquidation value of the collateral nor the borrower’s predicted repayment ability is known with confidence.
·  
Risk Grade 8 – Doubtful: Loans classified as Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable.  Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off.
·  
Risk Grade 9 – Loss: Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted.  This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be realized in the future.  Loss is a temporary grade until the appropriate authority is obtained to charge the loan off.
 
The following tables present the credit risk profile of each loan type based on internally assigned risk grades as of June 30, 2012 and December 31, 2011.
 
June 30, 2012
                       
(Dollars in thousands)
                       
 
Real Estate Loans
               
 
Construction and Land Development
 
Single-
Family Residential
 
Commercial
 
Multifamily
and
Farmland
 
Commercial
 
Consumer
 
All Other
 
Total
                               
1- Excellent Quality
$ 193   22,425   -   -   902   1,320   -   24,840
2- High Quality
  5,506   61,133   24,729   41   8,293   4,170   2,611   106,483
3- Good Quality
  26,624   94,484   123,709   3,637   36,186   4,065   16,210   304,915
4- Management Attention
  26,320   46,754   47,325   686   12,503   374   6   133,968
5- Watch
  11,861   11,701   5,263   720   325   115   -   29,985
6- Substandard
  15,994   18,842   6,219   201   1,182   161   -   42,599
7- Low Substandard
  -   -   -   -   -   -   -   -
8- Doubtful
  -   -   -   -   -   -   -   -
9- Loss
  -   -   -   -   25   -   -   25
      Total
$ 86,498   255,339   207,245   5,285   59,416   10,205   18,827   642,815
 
December 31, 2011
                       
(Dollars in thousands)
                       
 
Real Estate Loans
               
 
Construction and Land Development
 
Single-
Family Residential
 
Commercial
 
Multifamily
and
Farmland
 
Commercial
 
Consumer
 
All Other
 
Total
                               
1- Excellent Quality
$ 197   25,474   -   -   715   1,344   -   27,730
2- High Quality
  5,183   64,817   25,506   50   8,801   4,070   2,774   111,201
3- Good Quality
  27,675   100,388   136,137   3,448   36,585   4,259   16,509   325,001
4- Management Attention
  28,138   50,253   40,312   358   12,882   429   7   132,379
5- Watch
  15,923   11,767   2,795   728   622   89   -   31,924
6- Substandard
  16,696   14,352   9,665   209   1,041   154   -   42,117
7- Low Substandard
  -   -   -   -   -   -   -   -
8- Doubtful
  -   -   -   -   -   -   -   -
9- Loss
  -   -   -   -   -   145   -   145
      Total
$ 93,812   267,051   214,415   4,793   60,646   10,490   19,290   670,497
 
 
 
14

 
 
At June 30, 2012, TDR loans were $22.7 million, including $1.7 million in performing TDR loans.  Effective March 31, 2012, performing TDR balances reflect current year TDR loans only, in accordance with GAAP.  Previously reported TDR amounts reflect cumulative TDR loans from prior periods in addition to current year TDR loans.  At December 31, 2011, TDR loans were $44.1 million, including $15.1 million in performing TDR loans.   The terms of these loans have been renegotiated to provide a reduction in principal or interest as a result of the deteriorating financial position of the borrower.

The following table presents an analysis of TDR loans by loan type as of June 30, 2012 and December 31, 2011.
 
June 30, 2012
         
(Dollars in thousands)
         
 
Number of Contracts
 
Pre-Modification Outstanding
Recorded
Investment
 
Post-Modification Outstanding
Recorded
Investment
Real estate loans
         
     Construction and land development
22   $ 17,661   10,990
     Single-family residential
100     10,557   9,726
     Commercial
7     3,829   1,648
          Total real estate TDR loans
129     32,047   22,364
             
Commercial loans (not secured by real estate)
9     503   379
Consumer loans (not secured by real estate)
3     7   5
     Total TDR loans
141   $ 32,557   22,748
 
December 31, 2011
         
(Dollars in thousands)
         
 
Number of
Contracts
 
Pre-Modification Outstanding
Recorded
Investment
 
Post-Modification Outstanding
Recorded
Investment
Real estate loans
         
     Construction and land development
29   $ 19,762   12,840
     Single-family residential
241     25,541   24,846
     Commercial
15     7,200   5,013
     Multifamily and Farmland
1     322   209
          Total real estate TDR loans
286     52,825   42,908
             
Commercial loans (not secured by real estate)
21     1,711   1,083
Consumer loans (not secured by real estate)
8     124   142
     Total TDR loans
315   $ 54,660   44,133
 
(4)
    Net Earnings Per Common Share
 
Net earnings per common share is based on the weighted average number of common shares outstanding during the period while the effects of potential common shares outstanding during the period are included in diluted earnings per common share.  The average market price during the year is used to compute equivalent shares.

The reconciliation of the amounts used in the computation of both “basic earnings per common share” and “diluted earnings per common share” for the three and six months ended June 30, 2012 and 2011 is as follows:
 
For the three months ended June 30, 2012
         
 
Net Earnings Available to Common Shareholders (Dollars in thousands)
 
Common Shares
 
Per Share Amount
           
Basic earnings per common share
$ 1,161   5,544,160   $ 0.21
Effect of dilutive securities:
             
Stock options
  -      3,928      
Diluted earnings per common share
$ 1,161   5,548,088   $ 0.21
               
 
 
 
15

 

 
For the six months ended June 30, 2012
         
 
Net Earnings Available to Common Shareholders (Dollars in thousands)
 
Common Shares
 
Per Share Amount
           
Basic earnings per common share
$ 2,471   5,544,160   $ 0.45
Effect of dilutive securities:
             
Stock options
  -     1,964      
Diluted earnings per common share
$ 2,471   5,546,124   $ 0.45
               
For the three months ended June 30, 2011
         
 
Net Earnings Available to Common Shareholders (Dollars in thousands)
 
Common Shares
 
Per Share Amount
           
Basic earnings per common share
$ 281   5,542,703   $ 0.05
Effect of dilutive securities:
             
Stock options
  -     1,739      
Diluted earnings per common share
$ 281   5,544,442   $ 0.05
               
For the six months ended June 30, 2011
             
 
Net Earnings Available to Common Shareholders (Dollars in thousands)
 
Common Shares
 
Per Share Amount
               
Basic earnings per common share
$ 1,293   5,542,126   $ 0.23
Effect of dilutive securities:
             
Stock options
  -     1,646      
Diluted earnings per common share
$ 1,293   5,543,772   $ 0.23

(5)
    Stock-Based Compensation
 
The Company has an Omnibus Stock Ownership and Long Term Incentive Plan (the “1999 Plan”) whereby certain stock-based rights, such as stock options, restricted stock, restricted stock units, performance units, stock appreciation rights, or book value shares, may be granted to eligible directors and employees.

Under the 1999 Plan, the Company granted incentive stock options to certain eligible employees in order that they may purchase Company stock at a price equal to the fair market value on the date of the grant.  The options granted in 1999 vested over a five-year period.  Options granted subsequent to 1999 vested over a three-year period.  All options expire ten years after issuance.   The 1999 Plan expired on May 13, 2009.

The Company granted 3,000 restricted stock units in 2007 at a grant date fair value of $17.40 per share. The Company granted 1,750 restricted stock units at a grant date fair value of $12.80 per share during the third quarter of 2008 and 2,000 restricted stock units at a fair value of $11.37 per share during the fourth quarter of 2008. The Company recognizes compensation expense on the restricted stock units over the period of time the restrictions are in place (three years from the grant date for the grants to date).  The amount of expense recorded each period reflects the changes in the Company’s stock price during the period.  As of June 30,2012, there was no unrecognized compensation cost related to 2007 and 2008 restricted stock unit grants.

The Company also has an Omnibus Stock Ownership and Long Term Incentive Plan that was approved by shareholders’ on May 7, 2009 (the “2009 Plan”) whereby certain stock-based rights, such as stock options, restricted stock, restricted stock units, performance units, stock appreciation rights, or book value shares, may be granted to eligible directors and employees.  A total of 330,486 shares are currently reserved for possible issuance under the 2009 Plan.   All rights must be granted or awarded within ten years from the May 7, 2009 effective date of the 2009 Plan.
 
 
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The Company granted 29,514 restricted stock units in March 2012 at a grant date fair value of $7.90 per share. The Company recognizes compensation expense on the restricted stock units over the period of time the restrictions are in place (five years from the grant date for the grants to date).  The amount of expense recorded each period reflects the changes in the Company’s stock price during the period.  As of June 30, 2012, the total unrecognized compensation cost related to 2012 restricted stock unit grants was $219,000.
 
(6)
Fair Value

The Company is required to disclose fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company’s financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of the Company, but rather a good faith estimate of the increase or decrease in value of financial instruments held by the Company since purchase, origination, or issuance.

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.  These levels are:

·  
Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.
·  
Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
·  
Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market.  These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability.  Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

Cash and Cash Equivalents
For cash, due from banks and interest bearing deposits, the carrying amount is a reasonable estimate of fair value.

Investment Securities Available for Sale
Fair values of investment securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges when available.  If quoted prices are not available, fair value is determined using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.  Fair values for investment securities with quoted market prices are reported in the Level 1 fair value category.  Fair value measurements obtained from independent pricing services are reported in the Level 2 fair value category.  All other fair value measurements are reported in the Level 3 fair value category.

Other Investments
For other investments, the carrying value is a reasonable estimate of fair value.

Mortgage Loans Held for Sale
Mortgage loans held for sale are carried at lower of aggregate cost or market value.  The cost of mortgage loans held for sale approximates the market value.  Mortgage loans held for sale are reported  in the Level 3 fair value category.

Loans
The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. For variable rate loans, the carrying amount is a reasonable estimate of fair value.  Impaired loans with current certified appraisals are included in the Level 2 fair value category.  All other loans are included in the Level 3 fair value category, as the pricing of loans is more subjective than the pricing of other financial instruments.
 
 
 
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Cash Surrender Value of Life Insurance
For cash surrender value of life insurance, the carrying value is a reasonable estimate of fair value.
 
Other Real Estate
The fair value of other real estate is based upon independent market prices, appraised values of the collateral or management's estimation of the value of the collateral. Other real estate is reported in the Level 3 fair value category.

Derivative Instruments
For derivative instruments, fair value is estimated as the amount that the Company would receive or pay to terminate the contracts at the reporting date, taking into account the current unrealized gains or losses on open contracts.

Deposits
The fair value of demand deposits, interest-bearing demand deposits and savings is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.

Securities Sold Under Agreements to Repurchase
For securities sold under agreements to repurchase, the carrying value is a reasonable estimate of fair value.

Federal Home Loan Bank (“FHLB”) Borrowings
The fair value of FHLB borrowings is estimated based upon discounted future cash flows using a discount rate comparable to the current market rate for such borrowings.

Junior Subordinated Debentures
Because the Company’s junior subordinated debentures were issued at a floating rate, the carrying amount is a reasonable estimate of fair value.

Commitments to Extend Credit and Standby Letters of Credit
Commitments to extend credit and standby letters of credit are generally short-term and at variable interest rates. Therefore, both the carrying value and estimated fair value associated with these instruments are immaterial.

Limitations
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on many judgments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include deferred income taxes and premises and equipment. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

GAAP establishes a framework for measuring fair value and expands disclosures about fair value measurements. There is a three-level fair value hierarchy for fair value measurements.  Level 1 inputs are quoted prices in active markets for identical assets or liabilities that a company has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability.   The following tables present the balance of securities available for sale, mortgage loans held for sale and derivatives, which are measured at fair value on a recurring basis by level within the fair value hierarchy as of June 30, 2012 and December 31, 2011.
 
 
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(Dollars in thousands)
             
 
June 30, 2012
 
Fair Value Measurements
 
Level 1
Valuation
 
Level 2
Valuation
 
Level 3
Valuation
Mortgage-backed securities
$ 166,021   -   166,021   -
U.S. Government
               
sponsored enterprises
$ 2,930   -   2,930   -
State and political subdivisions
$ 107,675   -   107,675   -
Corporate bonds
$ 1,545   -   1,545   -
Trust preferred securities
$ 1,250   -   -   1,250
Equity securities
$ 1,314   1,314   -   -
Mortgage loans held for sale
$ 3,753   -   -   3,753
 
(Dollars in thousands)